There is a highly developed market where banks purchase life insurance to pre-fund future employee benefit expenses. These banks make use of variable life insurance contracts with separate accounts that hold debt instruments. Generally, banks are prohibited from owning securities classified as equities. Also, it is widely believed that this prohibition applies to assets held by a variable life contract, which is owned by a bank. Of course, as market interest rates fluctuate, the underlying market value of the separate account debt instruments goes up and down. Under GAAP (see FASB Technical Bulletin (TB) 85-4), the policy is accounted for on a mark-to-market basis. Seeking to avoid earnings volatility from their life insurance purchases, banks have bought Stable Value Wraps (SVWs) inside their separate accounts. For all intents and purposes, the SVWs promise that the debt security will earn a set rate of return—which will be reflected in the principal of the debt instrument. Upon surrender of the policy, the owner will receive the amount of principal reflected in the SVW promise—nothing more or less. As a result, earnings are stable and predicable even if market interest rates fluctuate widely and the underlying policy cash surrender value goes up and down.
The parties writing the SVWs are typically not the carrier issuing the life contract or the party managing the investment. The “writers” are either banks or insurance companies that are familiar with sophisticated derivative transactions.
Recently, other industries have become interested in using variable life insurance to pre-fund employee benefits. Typically, in other businesses, there is no regulatory prohibition to owning equities inside of a variable life policy. Notwithstanding, prospective policy buyers are anxious to avoid the exposure to mark-to-market accounting in years when the investments are under-performing expectations. Writers of SVW contracts have been reluctant to offer contracts when the separate account securities are equities instead of debt. The proposed fees for equity SVWs have been so high as to be unattractive to the market. Accordingly, we have discovered a need to invent a new approach to dampen the earnings volatility from owning equities for benefit funding purposes. We have observed a need for a new approach that will apply most often to equities and equity-like instruments held inside a separate account of a life policy. Also, we have observed that there is a need for a new approach that is equally applicable where assets are held directly by a company and accounted for using mark-to-market (e.g., tracking securities under SFAS No. 115).